UK manufacturers face record working capital pressure

Posted on 2 Oct 2017 by Jonny Williamson

The pressure on UK manufacturers to increase the amount of cash they have tied up in working capital has hit record highs in recent months, according to a new report from Lloyds Bank Commercial Banking.

Working Capital Tax Relief Manufacturing Jobs Economy Piles of Coins on Notes UK MAnufacturing - Shutterstock - Finance Investment - Autumn Statement
There are grants and support available from local councils and other central government initiatives, but they are often fairly restrictive – confined to regions or specific products.

Sustained growth in the sector and the fall in the sterling exchange rate, which has led to rising input costs and prompted many firms to stock up on inventory, mean UK manufacturers now have more money being used in the day-to-day running of the business than ever before.

Firms in the sector now need to balance devoting more working capital to boosting exports, for example, with freeing up cash that could be used to fund further growth or weather turbulent financial conditions.

The Working Capital Index – the measure developed by Lloyds Bank to track the amount of pressure on firms to either increase or decrease working capital – hit 126.1 in June 2017, a record high for the manufacturing sector.

This compared with a reading of 105 in the services sector, and 104.8 in construction.

A reading of more than 100 indicates pressure to devote more cash to working capital, while a reading of less than 100 indicates pressure to prioritise liquidity.

UK head of manufacturing for Lloyds Bank Commercial Banking, Dave Atkinson commented: “The fall in sterling has increased the competitiveness of British manufacturers’ exports, but it has also resulted in historic pressure to use more working capital.

“Companies that are growing naturally use up more cash in working capital, so in some senses this is to be expected.

“However, because import costs are currently high and are continuing to rise, manufacturers have been buying more materials in expectation of further inflation, causing the fastest build-up of inventory in the sector for more than 17 years.

“Meanwhile, some customers are demanding that firms hold more finished goods to ensure they can supply them quickly.

“What is concerning is that by locking up cash in these ways, manufacturers stop investing in other more productive areas of their business, whether that be investing in new people, creating new products or targeting new markets.

“If there were any economic obstacles on the horizon, this could leave businesses exposed to greater risk and unable to free up cash to prioritise liquidity.”

Lloyds Working Captial Index at a glance - Autumn 2017

The findings come from Lloyds Bank’s second Working Capital Index, a six-monthly report that uses Lloyds Bank Regional Purchasing Managers’ Index (PMI) data to calculate the pressure British businesses are under to either increase or decrease working capital.

Working capital is the amount of money that a company ties up in the day-to-day running of the business. Growing businesses tend to use more working capital, while companies focus on releasing cash from working capital when they are facing challenges.

The Index highlights that with the UK’s domestic outlook looking weaker, manufacturers are increasingly going to need to rely on exports for future growth.

While the current relative weakness of Sterling makes conditions for international trade benign, the practicalities of exporting mean that it often places even greater stress on working capital through shipping times and slower payments.

Atkinson added: “Manufacturers face a very specific set of challenges. On the one hand, they need to invest in capacity growth and devote higher working capital levels from international trading. On the other, they need to improve efficiencies and manage cash flow and the risk of overtrading.

“In the past, previous highs in this index have coincided with improving financial conditions. The fact that the index is currently climbing while financial conditions remain relatively low means businesses are taking on more and more risk.

“Our experience is that businesses that undertake a programme of working capital improvements can typically release around 3-5% of turnover in additional cash.

“But doing so successfully isn’t easy, so the time to undertake that work should be done ahead of embarking on further growth, a new exports programme, or before any possible future storm hits.”